Analysis: the Internet and Electricity

By Dave Lindorff |
Posted 07-01-2001

Analysis: the Internet and Electricity

Introduction

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Two summers ago, in a little-noted incident that every CIO should understand, anxious engineers at PJM Interconnection LLC, an electrical distribution company in Norristown, Pa., were preparing for the worst. An imminent shortage of electricity caused by a prolonged drought and heat wave threatened the 25 million people and hundreds of thousands of companies connected to PJM's electricity grid across the mid-Atlantic states.

In a foreshadowing of the shortages that plagued California and could yet threaten New York and other areas this year, PJM engineers attempted to buy extra power from neighboring grids, but also laid plans for rolling shutdowns across the region.

Then something unprecedented happened. On a real-time, Internet-based electricity marketplace built by PJM, corporate clients and distribution companies began to bid higher and higher for electricityup to $1,000 per megawatt hour, more than 10 times the normal rate. In response, energy producers from as far away as Florida began furiously selling power into the PJM grid. "Before we knew what was happening, we had a 1,000-megawatt surplus, and the crisis was over," recalls Ken Laughlin, vice president of market services for PJM.

Welcome to electric power in the Internet Age. Until recently, the business of buying and selling electricity was conducted by phone and fax, and one transaction took days. Today, thanks to the Internet, forward-thinking distributors and end-users like The Boeing Co. and ALCOA Inc. are making power-trading decisions in seconds. And they're anticipating the day when the purchase of electricity is all done automatically, around the clock. This fledgling revolution in some parts of the U.S. power system could help ease electricity shortages for progressive companiesand give CIOs a potentially powerful cost-cutting tool.

At PJM's three-year-old Net-based market, the grandfather of the online electricity markets, demand and prices are posted every few seconds, allowing producers and users to cut and close deals instantly. This Nasdaq-like market, available to PJM's more than 200 members, is not only changing the way energy is bought and sold, but also the way it is used. PJM members ALCOA and Bethlehem Steel Corp., for example, used to run full-tilt all the time, not knowing how much a unit of power was costing from one minute to the next. Now they can shut down some operations during peak periods when marginal rates soar. "What we're beginning to create is essentially a Nasdaq market for electricity," says Phillip Harris, president and CEO of PJM.

To be sure, only a fraction of the country's electricity is being traded so far through such exchanges. But energy experts predict that within the next five to 10 years there will be a real-time, national market for electricity. "The big picture is that energy is starting to be traded like pork bellies," says Ray Niles, director of equity research at Salomon Smith Barney Inc. "Eventually, every electron is going to be monitored and traded across the country on the Internet, and what PJM is doing now is very much on the cutting edge of that."

The insight for CIOs: Some companies are already using these markets to save money. At Boeing's Rotorcraft division in Ridley Park, Pa., for example, executives follow spot prices on PJM's market. Boeing can generate its own electricity for 14 cents a kilowatt hour, so when PJM's monitors show prices moving above that, Boeing turns its generator on, for savings that can exceed $50,000 a day.

But would-be traders, beware. A steep learning curve awaits CIOs entering these markets. "Those who understand the market are going to kill the ones who don't, whether they're buyers or sellers," says Roger Anderson, director of the Energy Research Center at Columbia University. Anderson cautions that no CIO should participate in the spot market for electricity alone; they will be beaten by those who are also playing the futures market. "You had a lot of people in California who were trading power but didn't really understand trading. They got killed by the companies that did know how to trade, like Enron Corp."

To tap into these new markets, CIOs mostly likely will need to team with CFOs, operations executives, energy officers and others. At companies like Ford Motor Co. and Boeing, that's already starting to happen. "The CIO should definitely be a major player on the team that develops the strategy," says Dr. Robert Handfield, Bank of America distinguished university professor of supply chain management at North Carolina State University. Handfield says that such teams are best led by supply management and operations executives. On the other hand, some companies may outsource energy management altogether; and such alternatives are already available.

Jolting an Industry

Jolting an Industry

PJM has always been ahead on the problem-solving front. It was founded in 1927 to help regional utilities handle outages and problems with peak demand. With the deregulation of utilities in the early 1990s, PJM was converted into an independent system operator, with a mandate to establish an open market for electric power. To do that quickly and cost-effectively, it turned to the Internet.

Its market is now moving at Net speed. At first, PJM tried posting prices hourly, Harris says. But customers began complaining that wasn't fast enough. "Now we post every three to five seconds," he says, "and I think ultimately we'll get it down to one-eighth of a secondthe time it takes for electricity to circle the globe."

PJM's Web initiative has sent a wake-up jolt through the energy industry. Companies like Houston-based Enronwhich creates markets for commodities, including electricityhave followed PJM onto the Web. Today, 60 percent of Enron's trades are done electronically. Meanwhile, Williams Energy Marketing and Trading Co., the power trading arm of Tulsa, Okla.-based Williams Companies, Inc., has shifted from a business largely done by phone and fax to one that uses the Web.

Besides developing various software programs that assign electric capacity, facilitate transactions and house auctions, PJM offers its proprietary software to other grid operators, helping to move the whole national grid toward a unified electric market. In 1999, ISO New England Inc., which manages the grid serving six states, bought and adapted PJM's software and has been running its own Web-based market ever since. Up to 28 percent of its power is traded on the site.

But Net-based energy trading is still a pipe dream for most. Although the 10 grids covering 48 states have deployed Web-based marketing systems, only a small percentage of all electric power is traded on them. Even at PJM, most of the approximately $600 million in online deals last year were between power generators and distribution companies, not with end-users. And even that trading represented only some 18 percent of the total deals made (most were two-party power contracts negotiated over the phone or at a table).

The problem: While it is possible for a company to buy and sell power online on PJM's site, for example, companies say that liquidity is still so poor that they can't really use it that way. "There are very few contracts trading at this point," says Gary Groner, vice president for energy at Ford Motor Land Services Corp. "You see extreme volatility in pricing, but you can't really manage that volatility because very little of it trades."

Potential for Abuse

Potential for Abuse

Not all Web-trading systems are alike. PJM has set up a multi-settlement market system that enables big end-users like Bethlehem Steel to buy power a full day ahead from generators or distributors. PJM acts most like the Nasdaq exchange, with PJM serving as the operator, handling settlements and collecting a fee for the service. ISO-NE and most other grids with Web trading systems aren't there yet: All of their trading is still just between producersthe companies that actually generate electricityand distributors, companies that primarily buy power and handle the transmission and distribution to corporate end-users. Enron, on the other hand, participates in each power deal made over its online market; it buys and sells power in every trade that is transacted over its site.

Critics say regulation is needed to match the rapid development of these electronic marketplaces, which are now either hosting or transacting billions of dollars worth of deals. Michael Aguirre, a San Diego securities law attorney who has filed cases against Enron, Reliant and a number of other power companies on behalf of California ratepayers, says that current energy marketsparticularly those that use the Internet"resemble the state of the stock market before 1929."

Aguirre says the temptation to manipulate the system to make an extreme profit is great. Participants, he says, are sharing their price and load information, which means everyone knows what everyone else is going to do. That allows them to hold out for the highest price, instead of competing to be the low-cost provider. Add to that a kind of "daisy-chain" trading process that leaves the last holder of a contract getting top dollar for the powerand everyone else along the way getting their asking priceand you have a situation where the consumer gets burned. In the recent California energy crisis, he says, "We think there had to be collusion in the energy market trading."

And there are other hurdles that must be overcomesome political, some physicalbefore electricity will be as fungible as oil or coffee, or as easy to sell and deliver over the Web as books from Amazon.com Inc. With no transmission lines of consequence crossing the Rocky Mountains, for example, California has been limited to other Western states in its efforts to buy its way out of its power crunch, and those states are facing the same capacity constraints. "The current power infrastructure is as incompatible with the future as horse trails were to automobiles," says Stephen Gehl of the Electric Power Research Institute, a Silicon Valley-based think tank.

True enough, for all the Internet can offer, it can't provide the engineering needed to make the nation's electric grids suitable for the power trading aheadsolid state switches, sensors to monitor the system, communications links and computing capacity to solve the complex problems of trading. The cost of doing all of this will be huge, but it's not evident who will take the lead. (see Power Shortage) "You've got this tremendous increase in complexity with all the new generator companies throwing power under the grid and no software or hardware to redistribute it and handle it," says Columbia's Anderson. "It's like an air traffic control system without the Federal Aviation Administration up there running things. This is a gigantic systems integration problem without a leader."

The next big step: so-called "smart meters" that, with other new technology, would fully automate these markets. EPRI's Gehl suggests that as this new technology gets developed and installed at end-user companies, more and more power providers will begin offering variable pricing based on demand. Right now, he says, smart meters are costly and few are installed, and with demand for variable pricing still limited, many providers just don't offer it. Demand pricing, Gehl says, "is the first step toward the construction of a Net-powered, automatic system that completely revolutionizes the existing grid."

On the horizon? A national market for electric power, a prospect the Federal Energy Regulatory Commission has anticipated with the creation of a new regulatory section, the Office of Markets, Tariffs and Rates. Industry watchers agree that once all states have deregulated electric power, variable pricing based upon demand will become the norm. At that point, smart metering, with demand adjusted automatically through direct links to the Internet marketplace, will probably reduce peak demand levelsand pricesdramatically. And brownouts or blackouts, if not a thing of the past, will become much less likely.

Dave Lindorffhas written for publications including The Atlantic Monthly and BusinessWeek magazine. He is author of Marketplace Medicine: The Rise of the For-Profit Hospital Chains. Comments on this story can be sent to editors@cioinsight.com.

Facts

Facts

The amount of power required to push a single byte of information across the World Wide Web is cut in half every 18 months, but the number of bytes traveling the Web is doubling every 12 months.

A data center uses as much electricity in one day as 12 typical houses use in a year.